Say it ain’t so.  How many more obscure, undercapitalized financial institutions are lurking in the midst?  According to a New York Times investigative article, and summarized here, Customer Asset Protection Company (Capco), based in Burlington, Vermont, may be at risk.

Capco provides catastrophic insurance to wealthy clients in the event their brokerage firm collapses.  Basically, it provides coverage above the $500,000 offered by the Securities Investor Protection Corporation (SIPC).

The concern with Capco sounds eerily similar to the abuses regarding credit default swaps in which some firms, including AIG, sold protection without having adequate reserve capital.  In Capco’s case, the article indicates that it might have only $150 million of capital to support an estimated $11 billion of potential claims.

It is prudent for investors and customers to hedge their hedges.  One example is to retain a public company as a hedge provider and then create a hedge on that hedge-providing company via puts/calls, short position, or both.  

In a Wall Street Journal opinion article published last month, former high-yield corporate bond salesman and trader, Michael Milken, who has his share of detractors, penned an opinion titled Why Capital Structure Matters.  He commented on this theme previously, including in a Forbes cover story titled My Story (March 16, 1992). 

Milken stresses that an appropriate capital structure evolves and corporate leaders must consider various factors in managing it.  Likewise, he provides recent examples (Alcoa and Johnson Controls) that deleveraging the capital structure of companies with uneven revenue streams can positively affect a company’s valuation, contrary to conventional financial theory.

He describes market signals that may prompt a CFO to consider modifying the capital structure.  For instance, when equity market values surpass replacement value of assets, then deleveraging should occur, when practical.

According to the article, there were unwise modifications to the capital structures of AIG, Merrill Lynch, Washington Mutual, Home Depot and CBS, among others.  What was the alleged error?  They borrowed a lot of money to repurchase expensive common equity – some at peak 2007 values – equity that was more valuable than the underlying corporate assets. 

Shoestring Venture and Sramana Mitra provide related articles, among several others.  Nevertheless, as Milken states, “It doesn't matter whether a company is big or small. Capital structure matters. It always has and always will.”

As mentioned in our previous blog, there is an article in today’s New York Times Magazine titled My Personal Credit Crisis, summarized here, which relates to the topics discussed previously.  The subtext of the article touches upon universal themes of human nature, on a personal basis and within a corporate environment.

Given the number of recent business mishaps and mortgage foreclosures, several people might relate to the author’s circumstances.  The experiences he recounts demonstrate psychological elements relating to materialism and insatiability that contributed to the unwise use of liar loans, credit cards, and home equity advances. 

Yahoo! Finance's TechTicker dubbed the story a subprime borrowing nightmare.

Well, perhaps Yogi Berra can best summarize the financial and housing crisis: “We made too many wrong mistakes.”